Tuesday, November 29, 2005

Canadian investors will be closely eyeing the fourth-quarter profit reports of the bank stocks this week now that Finance Minister Ralph Goodale has proposed tax changes that will significantly boost the value of their dividends.

The proposed taxation changes should boost the after-tax value of dividends from large corporations by 17 per cent, said Michael Goldberg, an analyst at Desjardins Securities Inc. in a report yesterday.

Bank of Montreal and Bank of Nova Scotia are scheduled to report today. Royal Bank of Canada is scheduled to report its fourth-quarter results tomorrow and Canadian Imperial Bank of Commerce on Thursday.

"The two banks that have the most relative upside are Toronto-Dominion Bank and Bank of Montreal at 15 per cent each," Mr. Goldberg said.

TD Bank is a "unique growth situation among the Canadian banks," while Bank of Montreal, a laggard, has the potential to report a positive earnings surprise today, he said.

Assuming that there is a 75-per-cent chance that the proposed tax changes will be implemented, Desjardins Securities estimates Laurentian Bank of Canada has a 9-per-cent upside potential. The upside potential of the other banks, according to the investment dealer, are as follows: Bank of Nova Scotia (6 per cent); CIBC (5 per cent); and Royal Bank (3 per cent).

However, UBS Securities Canada Inc. said yesterday that the proposed tax changes are only mildly positive for Canadian financial stocks.

Share prices are determined not only by the demand from taxable investors but also non-taxable investors such as pension funds and foreign investors, analysts said yesterday.

Scotiabank has the best capacity and inclination to ratchet up its dividend in the near term, said Jason Bilodeau, an analyst with UBS Securities.

The shares of Scotiabank, which closed yesterday at $47.09 on the Toronto Stock Exchange, up 9 cents, yield 2.89 per cent. During the past five years the dividends have increased by 21.4 per cent a year.

However, rising interest rates in Canada and slower growth could overshadow the beneficial impacts of the proposed tax changes, Mr. Bilodeau said.

Analysts forecast Scotiabank could earn 79 cents a share during the fourth quarter of fiscal 2005, compared with 66 cents a share a year earlier, according to Thomson First Call.

Its profit for fiscal 2005 is estimated at $3.10 a share, compared with $2.67 a share a year ago.

Scotiabank's "industry-leading excess capital gives [it] the flexibility to repurchase stock, raise the dividend and make acquisitions throughout 2006," said Mario Mendonca, an analyst with Genuity Capital Markets.

"We expect Bank of Nova Scotia to chip away at the bank's growing mountain of surplus capital with a healthy dividend boost, including a potential increase in the payout . . . and the pursuit of a more active share buyback program," Mr. Bilodeau said.

Analysts forecast Bank of Montreal earned a profit of $1.10 a share during the fourth quarter of fiscal 2005, compared with $1.04 a share a year earlier. Its profit for fiscal 2005 is estimated at $4.41 a share, compared with $4.43 a share a year ago.

Canada's three largest life insurers will likely enjoy only about half the share-price lift their bank counterparts can count on from Ottawa's pledge to lower dividend taxes, a financial services analyst is betting.

One reason is that the insurers have a much larger base of foreign investors, who do not stand to benefit from the pledge, TD Newcrest analyst Steve Cawley said yesterday.

The companies -- Manulife Financial Corp. and Sun Life Financial Inc. of Toronto and Great-West Life Assurance Co. of Winnipeg -- also have a smaller percentage of retail shareholders and lower dividend payout ratios.

As a result, Mr. Cawley said in the report that he is boosting his target prices for the companies by just 3 per cent to 4 per cent, "roughly half the positive impact we assigned to the Canadian banks." He said he has raised his 12-month price target for Great-West to $30 a share from $29, for Manulife to $75 from $73 and for Sun Life to $51 from $49.

About 25 per cent of Sun Life's shareholders and 45 per cent of Manulife's are foreign, while non-Canadian investors are a very small percentage of the banks', the report says. Mr. Cawley says if Sun Life's and Manulife's share prices increase, foreign investors may sell as the firms' shares become pricier relative to U.S life companies.

Friday, November 18, 2005

﻿On Sunday, Sept. 28, 2003, two cataclysmic events took place in Canada: Hurricane Juan slammed into the east coast, and Dominic D'Alessandro shook up Toronto's Bay Street.

D'Alessandro, president and CEO of Manulife Financial Corp. of Toronto, announced that his company would pay $11 billion in stock for John Hancock Financial Services Inc. of Boston. It was the biggest acquisition in Canadian history and immediately catapulted Manulife, which had demutualized in 1999, into the top tier of financial companies.

Though the havoc Hurricane Juan wreaked has largely been swept up, D'Alessandro's revolution continues to reverberate - and to pay returns to Manulife shareholders. It is now the second-largest company in Canada by market capitalization, exceeded only by Royal Bank of Canada, and the third-largest life insurer in North America, based on market cap, behind American International Group Inc. and MetLife Inc., both of New York.

More importantly, the Hancock deal has made Manulife a better company, improving profitability, boosting its shares and slashing its exposure to the Canadian market. In fact, in the first nine months of 2005, the U.S.'s contribution to Manulife's total profit was 30% larger than the Canadian component, effectively transforming the insurer into a U.S. company.

Manulife reported earnings of C$2.4 billion ($2 billion) for the first nine months of the year, up 33% from C$1.8 billion in the same period a year earlier, despite feeling the effects of a stronger Canadian dollar and property and casualty losses related to Hurricane Katrina. The company's profit in the first nine months of 2003 had been C$1.1 billion. "From the quarter that has gone by, the deal certainly looks to have gone well,'' says Ohad Lederer, an analyst with Veritas Investment Research Corp. in Toronto. "If there's downside, it's not evident.''

Adds James Keating, an analyst at RBC Capital Markets in Toronto, "This has proven an excellent deal, with distribution benefits better than expected, specifically in accelerated variable annuity and universal life policy sales.'' The company has improved profitability across a range of Manulife-Hancock product lines, Keating says.

Everyone was not always so high on the deal. The day after its announcement, Manulife's shares slid C$1.36, or 3.3% to C$39.49, and John Hancock lost 1.34%, to $33.84. Though the 18% premium to Hancock's previous day's share price seemed reasonable, analysts worried that the large deal would dilute Manulife's shares. They also wondered if Hancock was simply a consolation prize for Manulife, which had failed in bids to buy crosstown rival Canada Life Financial Corp. (which Great-West Lifeco Inc. of Winnipeg, Manitoba, bought for C$6.2 billion) and Canadian Imperial Bank of Commerce (a deal the Canadian government vetoed).

By the time the deal closed on April 28, 2004, however, Manulife's shares had risen to C$55, and as of Nov. 8, 2005, they had reached C$64.68 - a full 58% more than on the day the deal was announced.

D'Alessandro and his counterpart at Hancock, David D'Alessandro - the two are not related - promised savings of C$350 million over two years, and Veritas' Lederer says they appear to have made it. Dominic D'Alessandro told analysts on a recent conference call that projected synergies from the deal would likely reach $500 million. Another sign that synergies were achieved: Hancock's Canadian subsidiary, Maritime Life Assurance of Halifax, was integrated into Manulife within eight months of the deal's closing.

If the deal had one weakness, it's that it did not really strengthen Manulife's top management. Manulife is still run very much by Dominic D'Alessandro, aided by CFO Peter Rubenovitch, who has been with the Canadian company for a decade.

David D'Alessandro, placed in charge of the company's U.S. businesses when the deal was unveiled, left two months after the deal closed. John DesPrez III, who joined Manulife in 1991 as a counsel, now runs the U.S. operations.

Still, RBC's Keating says Manulife has gained expertise in businesses where it was absent previously, including banking, in which Hancock operates under the name Essex, and captive sales, which is branded John Hancock Financial Network.

So what does Manulife do next? Having approached Canadian Imperial Bank of Commerce once, press reports say Manulife may consider another bid if the Canadian government changes its policy barring bank-life insurance transactions. However, bancassurance is falling out of favor, with Citigroup Inc. and General Electric Co. ditching their life businesses in the past two years. Manulife is unlikely to pursue such a deal now.

The next likely option is to buy a U.S. insurer, though some say Dominic D'Alessandro may be content to grow the business organically. He is known as a disciplined acquirer and is no doubt reluctant to pay the current high valuations. "We are not proponents of further transformational U.S. deals, and we do not believe management are in that mindset either," Keating says.

Certainly, the outlook for the company is bright. A survey of 15 analysts by Thomson Investors Network show an average forecast of 18% growth in earnings per share in 2006, to $4.96 from an estimated $4.11 in 2005. Despite losses associated with Hurricane Katrina, Manulife has made a return on equity so far this year of more than 12%.

Meanwhile, Dominic D'Alessandro is proving he can do what no banker in Canada has done yet: transform a Canadian financial company into a largely U.S. company. And that is why his revolution has succeeded.

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Tuesday, November 08, 2005

Ottawa urged to ease restrictions to allow offer of policies to less-affluent customers

The Globe and Mail, Sinclair Stewart & Steven Chase, 8 November 2005

Toronto and Ottawa -- Canada's big banks, which for years have been prevented from marketing life insurance through their branches, are urging Ottawa to ease that restriction by allowing them to target less-affluent customers -- a group they claim is being underserved.

Officials from the banking industry have been meeting with the Department of Finance in recent weeks and are making a final push on the issue before the federal government releases its white paper on financial services. That paper will describe how Ottawa intends to rewrite legislation for the sector, and is expected to be published at the end of this month.

"We want to have access so branches could refer clients and use customer information to see what they need," said the head of one major bank, who described the lobbying approach as an attempt to stake out a middle ground with Ottawa. "We're saying to the government, 'why don't you open this up and let us into this?' "

A senior government official said Ottawa may still change its tack depending on the response to the white paper. "It puts out a direction to see what the reaction is. It's sort of like flying a flag," the official said.

The Canadian Bankers Association, an industry group, submitted a report to Ottawa in June insisting that banks should be allowed to provide customers with information on life insurance products through their branches, or refer them directly to their insurance operations. The banks also want to be able to mine their extensive databases to provide customers with insurance products tailored to their financial situation.

The issue is a sensitive one, however, and bankers are fearful of inciting the wrath of independent insurance brokers, a potent lobby group that carries considerable political heft. Both the banks and their rivals in the insurance broker trade have been furiously lobbying MPs in recent months to persuade them of the merits of their positions.

As a result, banking executives say the industry is focusing its recent discussions with Ottawa on the need to cater to lower-income Canadians, who they claim are poorly served by the current life insurance regime.

One executive said the idea is not to compete directly with life insurers, but to market plain, commodity-like life insurance products to customers who cannot afford policies of more than $100,000.

The average life insurance policy size has almost doubled from $105,000 in 1995 to $198,000 in 2003, making it an expensive purchase for many families, the CBA asserts.

Figures compiled by the banks show that only 60 per cent of families with a gross income of $40,000 or less own life insurance.

For those making above $80,000 a year, this number climbs to 81 per cent.

"The banks are well positioned to serve mid- and lower-income Canadians better than they're being served," said Caroline Hubberstey, a spokeswoman for the CBA.

The CBA is set to release the results of a new poll in a couple of weeks, just in advance of the white paper, showing that Canadians want more options in seeking out insurance.

Eighty-seven per cent of respondents said they would not feel obligated to purchase life insurance at their bank branch if this is where they had picked up marketing material.

If banks were able to mine their wealth of customer information to market specific insurance products, they would have to first get permission from customers to send them offers.

Sources say the banks were at an impasse several months ago as to how to lobby Ottawa over proposed financial services reforms.

Royal Bank of Canada, the country's biggest bank, and the one with the most significant insurance operations, wanted to ask that banks be allowed to sell life insurance products directly through their branches.

However, some of the other banks thought that was demanding too much, and the CBA agreed to lobby on a middle ground.

RBC made its own submission, calling on the government to let the banks begin selling directly.

"All banks agree that consumers want and need greater choice," said RBC spokesman David Moorcroft. "The only issue is how much choice we believe the government is prepared to give them right now."

But with a possible election looming, some banks are growing pessimistic that anything will change on the insurance file in the near future, and that this sensitive issue -- like mergers and income trusts -- may be pushed to the back burner for political reasons.

The white paper is still slated to be released in the next few weeks, and will then be sent to the House of Commons finance committee and the Senate banking committee for review.

The Finance Department is drawing up new legislation, reflecting the white paper, to be introduced in Parliament some time early in 2006.

Parliament must pass new financial sector legislation before the existing acts expire in October, 2006.

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Thursday, November 03, 2005

There's a lesson to be found in the recent quarterly results of Manulife Financial Corp. and Sun Life Financial Inc., but no one has to explain it to the country's banks: The insurers, unlike their Big Five brethren, have found a way to crack the lucrative U.S. market, and it's beginning to pay huge dividends.

Despite incurring a punishing charge for hurricane Katrina, Manulife was able to eke out a small increase in profit during the third quarter, aided mainly by its purchase last year of Boston-based John Hancock Financial Inc. and impressive contributions from its U.S. life insurance and wealth management businesses. Combined, these units produced 30 per cent more than the company earned in all of Canada during this period.

But Manulife, Canada's second-largest company, is not alone. Rival Sun Life, which has experienced problems in the United States, signalled last week it is getting back on track after some difficulties with regulators and a few years of pain in the fixed annuities business. Its U.S. businesses made $133-million during the quarter, or 45 per cent better than the previous year.

“Clearly the U.S. operations have been a significant driver of incremental profit for both Manulife and Sun Life,” said Robert Wessel, an analyst at National Bank Financial Inc.

“I think the life insurers have more competitive platforms in the United States, and now you're seeing the benefit of them relative to the banks.”

Of course, insurers have a natural advantage: They don't have the cost of establishing or buying expensive branch networks to service their customers. Instead, they focus more on designing products, and then rely on agents to sell them around the country. The banks, by contrast, are both manufacturers and distributors.

Mr. Wessel cautioned that it is difficult to generalize, especially since some banks, like Toronto-Dominion Bank, are only now laying the groundwork for their U.S. retail strategy. Others, like Royal Bank of Canada, have returned to an upward trajectory after stumbling for several quarters. Bank of Montreal may be the biggest exception, given it has been cemented in the U.S. Midwest for decades. Yet while its Harris Bankcorp subsidiary is an important contributor, it only accounts for about 20 per cent of the bank's annual profit, and performance has been uneven.

Manulife's results illustrate the gap between banks and insurers in terms of developing a U.S. presence. Its profit for the quarter reached $742-million or 92 cents a share, a 4-per-cent increase from $713-million or 87 cents a year ago. While the Canadian operations delivered a strong showing, it was the U.S. businesses — particularly on the investment side — that grabbed the attention of investors.

The company booked 46 per cent of its profit south of the border this quarter, and the growth opportunities there only figure to increase this number. Although some insurers have struggled in the current climate, chafing against both the rate environment and higher reinsurance costs spawned by the recent hurricane devastation, Manulife executives insisted Thursday the company is diverse enough to make money regardless of which way markets and rates are moving.

The stock markets, for instance, performed much better this year than last, providing a major lift to investment returns and wealth management profitability. Profit from U.S. wealth management rose to $163-million, up 37 per cent from a year ago. Without the effects of the stronger Canadian dollar, the increase would have been more pronounced, at nearly 50 per cent. The U.S. life insurance division reaped similar rewards, churning out $144-million in profit, an increase of 29 per cent.

Manulife chief executive officer Dominic D'Alessandro said Thursday that the insurer's performance underscores the success of the John Hancock merger, and suggested cost savings from the deal may reach $500-million, up from the previous estimate of $385-million.

In rich countries, financial services on the whole work remarkably well, despite the exotic salaries, the crackpot deals and the occasional bust. The vast majority of people have access to interest-bearing savings accounts, mortgages at reasonable rates, abundant consumer credit, insurance at premiums that reflect the risk of losses, cheap ways of transferring money, and innumerable sources of capital for funding a business.

By contrast, financial services for poor people in developing countries—a business known as “microfinance”—have mostly been awful or absent. With no safe place to store whatever money they have, the poor bury it, or buy livestock that may die, or invest in jewellery that may be stolen and can be hard to sell. Basic life and property insurance is rarely available. Home loans are costly, if indeed they can be found at all. For many people, the only source of credit is a pawnshop or a moneylender who may charge staggeringly high interest and beat up clients who fail to pay on time. In the Philippines, lenders who zip from town to town on motorcycles expect six pesos back for every five they lend. That translates into an annual interest rate of over 1,000% on a loan for a month.

For workers from poor countries who venture abroad to earn a better living, sending money home to relatives can be hugely expensive. Such remittances have become an important source of income in many developing countries, dwarfing other inflows of capital from overseas such as foreign direct investment and multilateral aid. But if the money is being sent, say, from America to Venezuela, charges can amount to as much as 34% of the sum involved, according to Dilip Ratha of the World Bank.

Why are the poor so badly served? The easy answer, that people who have little money do not make suitable clients for sophisticated financial services, is at most a half-truth. A better explanation, this survey will argue, is that the poor have been hurt by massive market and regulatory failure. Fortunately that failure can be, and increasingly is being, remedied.

In most developing countries, the barriers to providing financial services for the masses are all too clear. Inflation tends to be high and volatile; government is often incompetent; and the necessary legal framework for financial services is often missing. Property laws can make it impossible for poor borrowers to use assets such as their home as collateral for loans.

In the past, many countries have outlawed “usury”, and today many Islamic countries prohibit the charging of interest. Governments in developing countries often impose caps on the interest rates charged on loans for the poor. Despite their popular appeal, such caps undermine the profitability of lending and thus reduce the supply of loans.

Incomplete and erratic regulation of financial institutions has also undermined the confidence of the poor in the financial services that are available. When they can find an institution that will accept their tiny deposits, it often lacks the sort of government deposit insurance that is routine in rich countries, so when a bank goes under, savers suffer. For example, Indonesia's PT Bank Dagang Bali, once known for its work with poor clients, was closed by regulators last year after it was discovered to be insolvent and riddled with fraud. Many savers did not get their money back.

Corruption is also commonplace in many developing countries. A recent study by the World Bank found that in two poor states in India where the financial system is largely controlled by the government, borrowers paid bribes to officials amounting to between 8% and 42% of the value of their loans. Corruption raises the cost of every financial transaction, allows undesirable transactions to take place and undermines consumer confidence in the financial system. This, and the related curse of cronyism, explains why access to financial services in countries where the state has control over the financial sector is poorer than where it does not.

Inadequate basic public services add to the burden on financial firms. SKS, a fast-growing microfinance institution in India, has had to build back-office systems that can work on two hours of power a day; it closely monitors voltage when its computers are running and keeps a diesel generator on hand. Many others simply give up on the idea of modern technology and continue to use paper instead. This makes them vulnerable. The tsunami in December 2004 wiped out financial records at many small Indonesian banks.

But not all the blame goes to poor-country governments. Financial-services firms too have failed to do enough to deal with the lack of the sort of data (for example, about a client's financial history) that are taken for granted in rich-country financial systems, and to find ways of reaping economies of scale. Many have simply dismissed the possibility that serving the poor might be a viable business.

The start of something big

In recent years, at least in some parts of the world, this bleak picture has begun to change, first in credit, then in savings and more recently in remittances. Even insurance—not only the basic life sort but also more sophisticated forms for things like cattle and weather risk—is gradually being introduced.

These changes have recently received a lot of attention in policymaking circles. Grand claims have been made that credit can end poverty. A World Bank report by Thorsten Beck, Asli Demirguc-Kunt and Soledad Martinez published last month shows a strong correlation between lack of financial access and low incomes (see chart 1). Earlier research by the first two authors and Ross Levine concluded that a sound financial system boosts economic growth and particularly benefits people at the bottom end of the income league. A long-term study in Thailand by Robert Townsend of the University of Chicago and Joe Kaboski of Ohio State University showed that families with access to credit invested more, consumed more and saved less than those without such access.

What makes microfinance such an appealing idea is that it offers “hope to many poor people of improving their own situations through their own efforts,” says Stanley Fischer, former chief economist of the World Bank and now governor of the Bank of Israel. That marks it out from other anti-poverty policies, such as international aid and debt forgiveness, which are essentially top-down rather than bottom-up and have a decidedly mixed record.

Studies by Stuart Rutherford, who runs an experimental bank that provides loans and takes deposits in the slums of Bangladesh, show that the poor attach great value to having a safe place to keep money and some means of providing for life's risks, either through savings or, better still, through insurance. When financial services are available to them, the poor, just like the rich, snap them up.

In one sense, microfinance has been around for a long time. What is now generating so much hope and excitement is less the discovery of some entirely new way to deliver financial services to the poor than the effect of the rapid innovation that has taken place in the past three decades.

From pawnshop to Citigroup

The oldest financial institution in the Americas is a pawnshop on Mexico City's central square. Set up in 1775 under an edict by the Spanish crown to assist people in financial trouble, it is called Monte de Piedad, variously translated as the mountain of mercy or the mountain of pity. Pity or mercy come in the form of cash in return for valuables. Unclaimed items end up for sale in a series of glittering rooms near the main banking hall.

By transforming trinkets into capital, pawnshops perform an important (if under-appreciated) service, but they have three limitations. They advance cash only to people with assets. Their loans are based on the value of collateral, not of a business venture. And the valuables held as collateral cannot be used to fund businesses, as banks' cash deposits can.

There have been two notable attempts to find alternatives. One has been the creation by developing-country governments of state banks, particularly to finance the rural poor. These have mostly been a disaster. The other, much more successful one involved a number of organisations extending uncollateralised loans to very poor borrowers. In 1971, Opportunity International, a not-for-profit organisation with Christian roots, began lending in Colombia. ACCION International, also not-for-profit, made the first of what it called “micro” loans in 1973. Grameen Bank started in 1976 and soon became extraordinarily famous for offering “microcredit” to women in small groups.

To qualify, Grameen's customers had to be extremely poor, probably earning less than a dollar a day. To overcome the lack of collateral or data about creditworthiness, group members were required to monitor each other at weekly meetings, applying varying degrees of pressure to ensure repayment. As loans were repaid, people were allowed to borrow more. The group replaced the security that pawnshops gained from collateral. The model is not perfect, but it does have real virtues and has since spread around the world.

Why did these organisations start with providing credit? They assumed that poor people were unable to save, and that their sole need was for capital. But that was not the whole story. When BRI, a failing state-controlled rural lender in Indonesia, was transformed into a bank for the poor in 1984, it offered not only the usual loan products but also a government-guaranteed savings account with no minimum deposit. This has been an extraordinary success: BRI now has 30m savings accounts.

Nobody knows how many institutions are providing microfinance in some form, but the number is certainly huge (see article). They are growing fast and serving a vast number of people in absolute terms, although still only a small proportion of the billions who earn only a few cents a day. Local banking giants that used to ignore the poor, such as Ecuador's Bank Pichincha and India's ICICI, are now entering the market. Even more strikingly, some of the world's biggest and wealthiest banks, including Citigroup, Deutsche Bank, Commerzbank, HSBC, ING and ABN Amro, are dipping their toes into the water.

The downsides

Not everyone has been pleased with the prospect of better financial services for the poor. Islamic fundamentalists have bombed branches of Grameen in Bangladesh and attacked loan officers of other institutions in India. Maoists have looted microfinance offices in Nepal. The head of a microfinance effort in Afghanistan was murdered, possibly by drug traders.

To drug lords in Afghanistan, the availability of credit is unwelcome because it gives a choice to farmers who were previously forced to grow poppies for want of other ways to finance their crops. For the elites in closed markets running inefficient monopolies, credit raises the prospect of future challenges from entrepreneurs. For radical Muslims, it means that women (who in many countries make up the bulk of microfinance borrowers) are able to run viable businesses and become independent. And for everyone in poor countries, credit can mean social upheaval as merit and enterprise replace inheritance, family ties and position.

Nor does microlending always have a happy outcome. The clients of K-Rep, an excellent Kenyan microfinance bank in a small town on the fringes of Nairobi, are a pretty resourceful lot, but when the government stopped repairing roads, picking up rubbish and spraying for malaria, some were at their wits' end. Drainage in the marketplace was plugged by uncollected garbage and customers stopped coming. Maria Njambi, a single mother with a ten-year-old child, used to have a viable business selling fruit and vegetables she bought with credit from K-Rep, but she had to watch her inventory rot and has stopped repaying her loan. She is not alone in her misfortune. A report in 2002 by CARD, a microfinance organisation in the Philippines, offers the following explanation for borrower attrition: “It is a tragic fact that over time, husbands will fall sick, sari-sari [variety] stores will be robbed, harvests will be poor and children will die.”

Yet microfinance institutions typically claim extraordinarily low loan losses of 1-3%, a bit better than the rate for big banks in rich countries and much better than for the big credit-card companies. Given the difficulties facing businesses in poor areas, some critics question the accuracy of these figures. Many of the banks lending to the poor are not-for-profit organisations whose accounts are rarely scrutinised by outsiders. Much of their capital has been provided by governments or philanthropists, and often does not have to be repaid, so perhaps microfinance institutions are being quietly lenient with their customers. Indeed, large-scale defaults in microfinance may go unreported. The Townsend-Kaboski research project in Thailand informally tracked hundreds of microfinance institutions and found that in the five years before the Asian financial crises, 10% failed and a quarter stopped lending.

So there is room for scepticism, but also plenty of reason for hope. The biggest of these is just how much progress the industry has made in the past 30 years.

Tuesday, November 01, 2005

The high-performing bank wants to double this side of the business to claim its “natural market share”

Investment Executive, James Langton, November 2005

Bank of Nova Scotia has been one of the best-performing banks over the past several years, with one key exception — its wealth-management division. Now the bank has big plans for this part of its business, but it faces an uphill climb in its bid to move up the wealth-management rankings.

Among the Big Five banks, Scotiabank’s core business has been a standout. Given domestic constraints, the Big Five have looked outside Canada for expansion. Most of them have looked to the U.S., and have struggled with their strategies. They’ve also faced a variety of compliance and legal problems, with Royal Bank of Canada the latest to indicate it’s taking a US$500-million provision for ongoing Enron Corp.-related litigation.

But Scotiabank has steered clear of these issues and — by avoiding the U.S. and focusing on less developed markets — it has done an impressive job of global expansion. Its domestic wealth-management business, however, has been a noticeable laggard. Among the Big Five, Scotiabank fields the smallest wealth-management unit.

In an investor presentation held in mid-October, the bank revealed that, based on revenue, its wealth-management division has just a 7% market share. This is far below the 15% it considers to be its “natural market share,” based on the size of its other businesses.

How did it fall so far behind? For one, it has long had one of the smaller sales forces among the bank-owned dealers. For many years, BMO Nesbitt Burns Inc. and RBC Dominion Securities Inc. battled aggressively for status as the country’s biggest brokerage firm. They were both surpassed by CIBC Wood Gundy when it snapped up the retail sales force of a retreating Merrill Lynch Canada Inc. That left TD Bank Financial Group — which went its own way, building a full-service sales force from scratch — and Scotiabank with the smaller sales forces. Royal Bank and TD have also both enjoyed tremendous success with their asset-management businesses.

So, compared with its chief rivals, Scotiabank has been a bit lost in the shuffle in terms of scale and strategy.

Now Scotiabank is taking up the challenge. It is investing heavily in its wealth-management business in an effort to win back its “rightful” market share. At the investor presentation, which covered the bank’s overall domestic strategy, Scotiabank outlined plans to grow the wealth-management business by hiring new advisors, spending on training and technology, seeking acquisitions and pulling investment dollars from its large retail banking client base.

Tapping into an existing client base and cross-selling products is a challenge with which all the bank-owned dealers grapple. It has often proved easier said than done. Scotiabank does have significant assets to exploit, but it remains to be seen whether it can successfully pull it off.

Bank executives are constantly tweaking their referral systems and pronouncing them effective. But the reality on the ground is often the opposite. Cross-selling investments is no easy task. Although price can swing the sale of a product such as a mortgage from one bank to another, moving a brokerage account is a different proposition.

As CIBC World Markets Inc. explained in a report following Scotiabank’s presentation: “It makes sense to us that the borrowing needs of a customer are more prone to being shopped and, therefore, market share is more easily lost or gained in the lending marketplace. However, the investing business is even more relationship-driven in our view, which leads to materially stickier assets.

“Stealing market share is difficult at the best of times,” CIBC adds. “Unless Scotia can create a material competitive advantage through product innovation (typically short-lived), service excellence or building a larger sales force, growth in share will be a challenge.”

Scotiabank seems intent on trying all those avenues to gain a competitive advantage. Its Executive Vice President of wealth management, Chris Hodgson, says ScotiaMcLeod plans to hire about 200 full-service advisors over the next couple of years, increasing its advisor force to more than 1,000 by 2008. The parent also aims to double the retail bank’s investment sales force over the next few years, freeing up the 300 full-service advisors who cover bank branches to seek more new clients. He suggests that in 2006 these advisors will go from spending about 10% of their time on external sales to 50%.

Hodgson also suggests that the bank has invested in products and support systems to enhance its chance of effectively cross-selling. This means new investment products for the bank’s branches, including proprietary funds and external products; beefed-up training; more financial planning tools; and new technology for advisors’ desktops. New contact management and portfolio management software will be rolled out in 2006.

Scotiabank advisors have long griped about technology in Investment Executive’s annual Brokerage Report Card. It was an issue in the latest version of the survey, conducted earlier this year. Scotiabank ranked third among the Big Five bank-owned dealers. This was only good enough for ninth spot overall, though, as advisors at the independent dealers showed far more love for their firms.

While new technology always holds the promise of improving efficiency and enhancing productivity, advisors are often rightly leery. Large new rollouts always carry implementation risks and new technology often doesn’t live up to its promise. So, how much productivity improvement can be wrung from the existing sales force through new technology is a big question.

Bulking up the sales force will certainly grow revenue, but this isn’t an easy task, either.

Much of this growth will probably come in the form of new recruits who require training. Many recruits will be unproven as salespeople, and the risk is that some will fail; the really good ones could move on to more entrepreneurial shops.

Also, growing by recruiting new advisors is a considerable challenge. In its report, CIBC recalls that Scotiabank delivered an investor presentation in 2001 that highlighted similar opportunities for growth. Back then, Scotiabank predicted it could grow its sales force from 850 advisors to almost 1,300 in two years. But, four years later, it only has about 840 advisors. “Clearly growth of the channel is not easy, and we don’t believe it gets any easier from this point forward,” CIBC notes.

The CIBC report also suggests that Scotiabank may be asking too much from its branch-based sales force. CIBC reports that in 2001 Scotiabank experienced a “significant challenge” in having branch staff handling an average of 240 households each. “Now the bank expects the sales force to manage 500 households at a peak load.

This appears to us to be a significant challenge if the bank wants to achieve more than maintenance activity,” the CIBC report says. “While we suspect Scotia’s technology can provide an edge in attempting to be proactive, the caseload will probably result in a reactive sales force.”

Scotiabank certainly seems to recognize the challenge of growing its sales force organically. It is willing make acquisitions to complete its expansion, it says. Analysts estimate that Scotiabank is sitting on almost $5 billion in capital that could be spent on acquisitions. Hodgson suggests the bank is looking for deals large and small, from significant to secondary and in every area of the wealth-management business — from asset management to distribution — as well as high-end investment-counselling types of businesses.

However, having the appetite and resources for deals is easier than finding suitable and attractive acquisitions. “While we have diligently sought out acceptable targets and looked at several potential opportunities over the past year, we have not yet found the right target at the right price,” Hodgson notes.

This is a familiar refrain in the Canadian retail investment business. The asset-management business looks to have plenty of excess capacity and be ripe for consolidation, yet appealing deals are few and far between. The largest firms in the mutual fund business either have very large foreign parents or are so closely held that it would be hard to pry them free. Smaller firms abound, but there are few that are big enough to make a meaningful difference to the bottom line or to justify the inevitable risk and pain of integration.

Similarly, on the distribution side, the significant players are mostly bank-owned, foreign-owned or closely held — all conditions that make meaningful acquisitions a significant challenge.

“We will continue to seek opportunities to invest our capital by acting judiciously and with discipline and conviction when the opportunity is right,” Hodgson pledges. “While a key component of our focus is a significant domestic acquisition, we will also be looking at targeted ‘bolt on’ acquisitions and strategic alliances, which could include joint venturing and/or white labelling.”

An acquisition is a quick way to build scale, but could prove difficult. “In our view, gaining new customers is probably the key for [Scotiabank] and critical in wealth management,” notes Blackmont Capital Inc. analyst Darko Mihelic in a report. However, he suggests, Scotiabank’s hiring plans aren’t likely to “affect near-term results meaningfully.... Acquisitions are possible, but its track record suggests unlikely.”

Notwithstanding the challenges, Scotiabank has grown its wealth-management revenue over the past couple of years. “The performance of the wealth-management subgroup has been a quiet strength for Scotiabank in 2005,” notes Genuity Capital Markets Ltd. in its report on the meeting, noting Scotiabank’s wealth-management business has recorded double-digit revenue growth, well ahead of its rivals.

In his presentation, Hodgson suggested that the group would generate about $930 million in revenue for fiscal 2005. But the opportunity exists for the bank to more than double that by reaching its “natural” market share. Even so, achieving this ambitious goal would only put it on par with the fourth-ranked bank in the wealth-management game.

If there’s a silver lining, it’s Scotiabank’s massive potential for growth. But, given the ferocity of the competition, living up to that potential won’t be easy.